Duration is something usually associated with bond funds, not equity income, but for the £20.1m Legg Mason Global Equity Income fund, this is one of the ways the fund has been differentiating itself from peers while boosting dividend yield.
Paul Ehrlichman, portfolio manager of the fund, notes the lowering of duration is not a typical concept but is something the team has initiated in the past 12-18 months.
“Equities, particularly dividend-yielding equities, can be very long duration if they lack growth and… can be very vulnerable,” he explains.
Equities with a 2-3 per cent yield could have a duration of 30-50 years, which is not ideal if interest rates and growth expectations rise. However, the manager notes that the fund’s strategy means, compared with its peers, it has a duration of just a couple of years. “We were going to get our investment back in a year or two based on the growth of the firms and the dividend growth.
“So by lowering duration, what we did was emphasise dividend growth. Looking at our current portfolio, dividend growth has increased 42 per cent [on a five-year basis] – it’s significant and it was something we targeted. You can lower duration through valuation; you can lower duration with earnings growth and dividend growth. We do that by finding depressed profitability situations, and this has led us to the sectors, countries and a capitalisation structure we’re in now.”
The fund’s investment process is a combination of three things, using an elimination- rather than selection-based approach.
This ‘elimination’ part of the process uses quantitative and qualitative steps to eliminate a large section of the investable universe, including screening for value traps and seeking firms that are undervalued but still industry leaders with growing market share. This cuts the available stocks from roughly 17,000 to a couple of hundred.
The remaining two parts of the process are ‘combination’ – looking for companies that meet a checklist of factors – and finally ‘diversification’ across countries, sectors and individual stocks to ensure the portfolio is driven by factors such as undervaluation, profit growth, timing and quality.
On the income aspect of the fund Mr Ehrlichman notes the team takes an ‘enterprise yield approach’, which is a more holistic process looking at the combination of dividends, dividend growth, buybacks and the ability to deliver excess positive returns on capital.
“We also use caps,” he adds. “We have more than half the portfolio in small and mid caps right now; we find that some of the most fantastic growing yield franchises around the world are small and mid caps.”
Since its launch in May 2008 to November 26 2013 the fund has returned 51.41 per cent, ahead of both the MSCI World index return of 50.91 per cent and the IMA Global Equity Income sector average of 47.31 per cent, according to Morningstar.
The fund’s one- and three-year performance is equally good, outperforming both the index and the sector average in both periods, although its five-year return of 100.19 per cent is just behind the MSCI World figure of 102.1 per cent, but well ahead of the sector average of 92.4 per cent.